Little Excitement Around TransAlta Corporation's (TSE:TA) Earnings

With a price-to-earnings (or "P/E") ratio of 7.4x TransAlta Corporation (TSE:TA) may be sending very bullish signals at the moment, given that almost half of all companies in Canada have P/E ratios greater than 16x and even P/E's higher than 32x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, TransAlta has been doing quite well of late. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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Is There Any Growth For TransAlta?

TransAlta's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered an exceptional 102% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 31% per annum as estimated by the six analysts watching the company. Meanwhile, the broader market is forecast to expand by 9.0% each year, which paints a poor picture.

With this information, we are not surprised that TransAlta is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of TransAlta's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 4 warning signs for TransAlta (1 doesn't sit too well with us!) that we have uncovered.

If you're unsure about the strength of TransAlta's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.